For goal-oriented portfolios, it is better to invest in bank deposits where the maturity value is known
For goal-oriented portfolios, it is better to invest in bank deposits where the maturity value is known
A well-known dictionary defines happiness as “a force that brings good luck or bad luck”. Individuals typically attribute success to their abilities.
The behavior of attributing success to ability and failure to bad luck is called self-attribution bias. In this article, we discuss how such biases shape our attitude toward happiness in our personal finances.
success versus ability
If skill is all it takes to be successful, then why are so many not-so-skilled people rich and so many brilliant and skilled people have boring day jobs?
It is natural to attribute success to skill and hard work, and failure to laziness, especially when the latter relates to someone else. The fact is that happiness is an integral part of anyone’s success. You might get cocky if you suffer from self-attribution bias and take on more investment risk than required. Self-attribution bias also leads to hindsight bias.
This refers to our behavior of looking back at your decisions and believing that events were foreseeable. Hindsight bias might cause us to attribute a successful outcome to our ability to correctly predict the event.
The problem is that happiness has two sides. Risk is the possibility that your seemingly good decision may have an adverse future outcome (bad luck?).
Luck (often attributed to skill) is when a seemingly bad decision turns into a positive outcome. The point is that we rarely consider a decision bad when we experience a positive outcome. As a result, the role of luck in investing success is rarely acknowledged.
Customize investment calls
If you believe luck plays an important role in your personal finances, how should you adjust your investment decisions? Active funds are designed to generate positive alpha. So the investment performance of such a fund depends on two elements – the skill (and luck) of a portfolio manager and your skill (and luck) in choosing the right manager. This may explain why an active fund you select does not consistently generate positive alpha (excess returns a fund generates relative to its benchmark).
Passive funds are solely dependent on the performance of their reference index. The investment performance of such a fund depends on your luck that the market will perform well over the time horizon of your life goal – a factor to which you are exposed anyway since you cannot diversify the market risk. Your investment success therefore depends on the market result (both active and passive funds) and the performance of the fund manager (only active funds).
However, this in no way diminishes the importance of your ability to balance current lifestyle, save for the future and select investment products. However, despite your best efforts, if the portfolio manager’s bad luck coincides with the time horizon for your life goal, you may not be able to achieve your goal. From the above, passive funds seem to be better suited for a goal-based portfolio since you are only exposed to one factor of luck (market outcome).
Conclusion
Luck plays an important role when the outcome is uncertain. Some attribute such a result to chance. The point is that luck (or randomness) plays a less important role in your bank deposit investments compared to your stock investments. Why? Regardless of the small amount of credit risk you are exposed to, the maturity value of a cumulative deposit or a recurring deposit is known. That’s one of the reasons you need to invest in bank deposits for your goal-oriented portfolios.
Even those who acknowledge the role of luck in their investment success are likely to offer different explanations. Happiness can be explained with astrology, philosophy or spirituality, for example. Whatever your personal beliefs, remember that the outcome of your personal investment decisions depends on luck and skill. So acknowledge the role of luck (luck) and mitigate your self-ascription bias and hindsight bias. This could improve your financial well-being.
(The author offers training programs for individuals to manage their personal investments.)
